Friday, November 20, 2009

Dillard's (NYSE:DDS): Upgraded to Buy at Deutsche Bank, target raised to $28 - not your daughter's jeans!

Deutsche Bank is upgrading Dillard's (NYSE:DDS) to Buy from Hold with a $28 price target (prev. $13.50).

Based on Dillard’s merchandising and cost control initiatives, improved inventory management and recent operating trends, the firm believes the company is better positioned than nearly all investors would have anticipated to grow EPS significantly in both the near and long term. Management began implementing several initiatives in 2007 and 2008, which up until recently have been masked by the deteriorating economy. Deutsche believes that Q3:09 results area testament to inventory and cost containment initiatives that have been undertaken and are a glimpse into what is to come. Given the improved operating efficiencies they are significantly increasing their EPS estimates, their price target and upgrading DDS to a BUY rating, from HOLD.

Historically considered a laggard, now proving the skeptics wrong
While Dillard’s management was working behind the scenes on new merchandising initiatives and ways to right-size the business in 2007, the company got the reputation of a laggard versus some of their competitors as they experienced deterioration across many metrics including comps, operating margins, and return on invested capital, etc. Additionally, the company’s minimal communication with investors and the Dillard family’s significant economic ownership and control was perceived in a negative light. In late 2007 and early 2008, as the economy was beginning its vicious Great Recession downward spiral, the company began receiving letters from activist investors demanding initiatives be undertaken to improve the operations of the business.

These activists recommended initiatives including:

1) Reduce the company’s cost base – through sourcing, rationalizing SG&A expenses
and reducing capex

2) Improve inventory management – institute initiatives to moderate inventory levels as
the stores appeared over-inventoried

3) Refine merchandise assortment – aggressively re-merchandise with a new vendor
selection, exclusive brands, updated private label and in-house collections

4) Enhance brand marketing – add more image and lifestyle campaigns to
communicate a revitalized message

While Dillard’s did not to respond publicly to these suggestions, it is clear to Deutsche now that many of these suggestions were being implemented at the company.

Normalized EPS
Deutsche continues to believe that the cyclical recovery has not yet been priced into many of retailers’ shares. They expect the improving economy over 2010-2011 to drive strong sales, EBIT margins and EPS growth across most of their Broadline names, including Dillard’s. They expect Dillard’s to see significant EBIT margin expansion over the 2009 – 2011 period (+234bp), given the strong cost discipline, efficiency gains, and streamlined inventory levels. The analysis assumes Dillard’s can eventually return to their historic peak EBIT margin of 8.5%, which may seem like a lofty goal as it would likely take several years for the company to return to these levels. However, applying a normalized multiple (15x) to the implied EPS, implies a share price of $56, or nearly 300% upside.

How good can it get?
Next, the firm updated their “How Good Can it Get Analysis,” which increases their FY10 comp estimate (-2%) by 100bp to 500bp increments and our FY10 gross margin estimates (+91bp) by 10bp to 50bp, but maintains their SG&A dollar estimates. If Dillard’s saw an improvement in comp sales in FY10 to +1% and a GM increase of 120bp, they would report a year-over-year increase in FY10 EPS of about 180%, compared to Deutsche estimate of a +57% increase. If discretionary spending drove the FY10 comp to +3% and gross margins to +140bp, that would result in a year-over-year increase in EPS of about +270%. The company will clearly see significant upside if sales and margins see some improvement from current levels, further supporting their Buy thesis.

Revising Q4:09, FY09, FY10 and FY11 EPS Estimates
Based on Q3 results and the company’s line-item guidance provided, the firm has updated their Dillard’s model. For Q4:09, they now expect EPS to be $1.10 (vs. -$0.31 LY), up from their previous estimate of $0.17. For FY09, they are projecting EPS of $0.80 (vs. -$1.56 LY), up from their previous estimate of -$0.61. Deutsche is also revising their FY10 EPS estimate upward to $1.25 (+57% y/y), from $0.43 previously, and their FY11 EPS estimate is now $2.01 (+60.2% y/y), up from $1.30 previously.

Notablecalls: Certainly an interesting call from Deutsche's Retail team. While the new target of $28 is the new Street high target by a wide mile, Deutsche is saying that based on normalized earnings the stock could be worth $56, implying 300% upside.

This is bound to generate strong interest in the name today.

Dillard's has been paying down debt at a fairly fast rate and has significant real estate holdings that may actually be worth double the current share price (Deutsche est. $41 NAV). The Dillard family and other insiders own 25-30% of the co and control 2/3 of the board votes due to dual Class A/Class B share structure.

There's a 12% short interest in the name and the chart looks good for a breakout.

I think DDS can trade above the $15 level today with $15.50+ certainly not out of the question.

The main risk here seems to be the general market. Futures are in the red early going and I'm not quite sure we will see any meaningful bounces until the markets give back some more of the recent gains.


Roy said...

Perhaps the improvements mentioned are going on in the larger stores, we saw this yesterday at the store nearest the airport in Tampa, Fl. These improvements have not made it to the smaller stores, ie, Vero Beach, Fl.

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